Schroder Global Recovery Fund

“The one thing in stock markets that never changes is humans…human emotions. We look at the parts of the market that others don’t, won’t or can’t” – Nick Kirrage 

Overview

The Schroder Global Recovery Fund applies a disciplined value investment approach, seeking to invest in a select portfolio of securities that are significantly undervalued relative to their long-term earnings potential. The Fund invests in companies worldwide that have classic recovery characteristics, these are companies that which trade on low multiples of recovered profits, but where long-term prospects are believed to be good. Its major strength is the disciplined focus  on buying out-of-favour companies at all stages in the investment cycle. While valuation-driven philosophies may fall in and out of favour, over longer time periods this investment style has shown the potential to deliver higher returns. 

Portfolio summary 

The Fund’s investment objective is to provide capital growth and to outperform the MSCI World Index (after fees) over the medium to long term.

Style Value
Number of securities 30 - 70
Position size Maximum position size 10%
Sector weights Maximum of 35% in any one sector
Country weights Maximum of 50% in any one country
Currency Unhedged

Nick Kirrage at the London Value Investor Conference 2016

A highly engaging presentation where Nick explains their view of value, Graham rather than Buffett, and explores “successful failures”.  He discusses the poor performance of their best stock pick from the prior year’s conference, Lonmin, and how they deal with occupational hazards in their process.  (Note: this is a UK conference  and the UK Recovery Fund is discussed in GBP.)

 

Key benefits

The benefits of investing in the Fund include:

Unconstrained: The Fund is completely benchmark unaware with a focus on stocks that will deliver absolute returns over the long term 

Contrarian: The Fund adopts a disciplined value driven approach 

Bottom up: The investment team has a strong focus on micro analysis, not macro, using skills in company analysis and valuation 

Low turnover: A thoughtful, patient, investment style, targeting long-term value creation.

What are the risks?

The Schroder Global Recovery Fund is suitable for investors who have a long time frame for investing and are prepared to accept high volatility in returns, including negative returns, over the short term.

All investments involve risks however Schroders actively re-assesses and manages risk at every stage of the investment process.  The main risks specifically with investing in this Fund are market risk, equities and company risk, derivatives risk and risks associated with international investing such as movements in exchange rates.  

For further details about the risks of investing in this Fund please refer to the Product Disclosure Statement.

Insights

Quick links

Investment approach

Recognising the long term benefit of a value strategy, we seek to identify stocks which trade at a substantial discount to their fair or intrinsic value and where we believe that profits growth will surpass expectations. We believe these stocks provide the most attractive investment returns over the long term.

The strategy has a distinct contrarian approach with a focus on stocks that will deliver absolute returns over the long term. It therefore has higher volatility than market indices, though we believe strongly that this is more than compensated for by the potential of longer term outperformance.

Investment process 

Idea Generation

Quantitative screens are used to highlight companies that have underperformed the equity market, are attractive on a variety of valuation measures and have operating returns substantially below their peers.

Fundamental analysis

We believe strongly in the benefits of independent fundamental research. We spend considerable time constructing a model for each company based on at least one cycle’s worth of company report and accounts.  The main aims of the model are:

–       To verify the output of the screening process and / or the veracity of the company’s financial disclosure

–       To understand the main dynamics of the business; operating leverage, cash conversion, sales volatility etc.

–       Investigate balance sheet strength and perform sensitivity analysis

–       Investigate historic levels of profitability and enable conservative modelling of recovery.

Risk Management

We view risk as the probability of permanent financial loss and to achieve superior long term returns, capital losses need to be minimised. We therefore look at risk in absolute terms focusing on three main sources of risk:

We attempt to minimise absolute risk by concentrating on companies with low valuations, resilient earnings and strong balance sheets. This margin of safety is designed to protect capital in event of an unexpected adverse outcome. 

Key features

Fund Inception date August 2017 (strategy inception October 2013)
Valuation Daily
Minimum investment Wholesale class - $20,000 
Professional class - $500,000
Buy/sell spread^ 0.30% on application; 0.15% on redemption
Entry/exit fees Nil
Management costs (ICR) Wholesale class - 0.98% p.a.
Professional class - 0.80%p.a.
Performance fee N/A
Distributions Usually last business day of June and December
APIR code Wholesale class SCH0095AU
Professional class SCH4757AU
mFund code SCH45 

^Subject to change. Refer to the Buy/Sell spreads page in the Fund Centre

Who does this fund suit?

The Fund is suitable for Australian investors that are seeking a high conviction strategy and are comfortable with the risks associated with an equity-based investment. Because the strategy will depart materially from index performance, in both directions, it is suitable for those investors with appropriate time horizons and a tolerance and patience for index deviation. 

A contrarian approach to investing

We use a contrarian approach to seek out sound businesses with long-term value potential we believe is not reflected in the share price.

We do what other investors don’t, won’t or can’t. Taking a contrarian approach we look for ideas among unloved businesses and industries, aiming to buy when most others are keen to sell and sell when they want to buy. That’s easy to say, not so easy to do and you can risk looking really foolish in the short term. But pick the right companies with real recovery potential and stick with them for long enough, and you have the potential to generate much higher returns than the general market.

Australian Unit Trust launched on 18 August 2017 

The Schroder Global Recovery Fund was launched in Australia on 18 August 2017 (please refer latest fund report for early performance), but Schroders has been running this strategy globally since October 2013.  The below table shows the returns for the Schroder ISF Global Recovery strategy which the local Fund mirrors.

*Inception date: 18 August 2017
Past performance is not a guide to future performance and may not be repeated.
Representative Portfolio displayed to show the strategy's performance over longer history. Converted to AUD. Net of wholesale class management fee of 0.98% p.a.
^ Partial financial year from inception of the strategy. ** Inception date of the strategy 9 October 2013.

The success of a Recovery approach

Top quartile long-term performance.

Despite a much longer track record, Nick Kirrage and Kevin Murphy have also been running the highly successful Schroder Recovery Fund for over 11 years. This is a UK based fund with the ability to invest 20% of its assets outside the UK.

Over the last 10 years the fund has returned 153% compound return, or 9.7% p.a. in GBP. (Please remember that past performance is not a guide to future performance and may not be repeated.) The nature of a true ‘recovery’ strategy can be volatile over short periods, but time and time again over the long term, it has proved its potential to give investors attractive returns.

Source: Morningstar, bid to bid, net income reinvested, net of fees, GBP as at 30 June 2018. Based on a representative recovery strategy managed by Schroders since launch. 1Rank and quartile based on UK Recovery strategy within the  IA UK All Companies Sector.

Past performance is not a guide to future performance and may not be repeated. The performance of the Schroder ISF Global Recovery Fund is based in GBP and does not represent the performance of the Australian Unit Trust which may differ to the above performance due to exchange rate fluctuations 

Being different isn’t always in favour in the short-term but volatility is dampened over time. The downside is patient investing doesn’t work every day.

This chart shows how the Schroder UK Recovery strategy has performed against its benchmark, the FTSE All Share index. While the fund can experience periods of outperformance and underperformance from month to month, it has significantly outperformed over the longer term.

Source: Schroders, bid to bid, net of fees, net dividend reinvested from 31 July 2006 to 31 March 2018. Based on a representative recovery strategy managed by Schroders since lunach. Past performance is not a guide to future performance and may not be repeated. The performance of the Schroder ISF Global Recovery Fund is based in GBP and does not represent the performance of the Australian Unit Trust which may differ to the above performance due to exchange rate fluctuations. 

Two recovery funds, one familiar pattern of returns

Despite the very similar profile of returns, there is only 28% commonality by weight between the funds.

Performance Source: Schroders, net of fees. UK Recovery strategy A Acc in GBP relate to FTSE All-Share Inded, from 31 October 2006 to 31 March 2018. Schroder ISF Global Recovery A Acc in USD relative to MSCI World Index, from 31 October 2013 to 31 March 2018. The performance is calculated on the portfolio. Individual performance may differ as a result of inital fees, the investment date, the date of reinvestment and dividend withholding tax.

Past performance is not a guide to future performance and may not be repeated. The performance of the Schroder ISF Global Recovery Fund is based in GBP and USD and does not represent the performance of the Australian Unit Trust which may differ to the above performance due to exchange rate fluctuations. 

With so many funds that look similar to one another in the market, our approach is genuinely different

The overlap between the Schroder Global Recovery Fund and other ‘recovery’ and special situations funds is typically negligible. Although the potential of our strategy to deliver strong long-term returns is proven, most investors eschew it because stocks with recovery potential can be volatile and there will inevitably be some companies that perform disappointingly. It’s a way of investing that requires a hard head and an open mind.

We follow an explicit value process which ensures no style drift


Source: Morningstar Direct, report date August 2018, for latest available fund dates. For illustrative purposes only and not a recommendation to buy or sell shares.

Current views

The difficult past decade for value has not won it many friends, and as a result, many investors have abandoned it in favour of different types of strategies. We seek to offer an increasingly unique proposition of being positioned where we believe the potential for performance will be. - Nick Kirrage and Kevin Murphy, Fund Managers

Please refer to our insights page for latest opinions, or the latest fund report.

A benchmark unconstrained strategy.

 

Source: Schroder ISF Global Recovery, FactSet, as at 30 June 2018. Based on unaudited data. For illustrative purposes only and should not be viewed as a recommendation to buy or sell. 

Outlook and strategy

–         The world is, seemingly, in a bull market in everything. Just take a few headlines from this past week alone: US stocks, already at all-time highs, have hit their sixth consecutive closing high, which is the first time that has happened for 20 years. In debt markets, Ireland has issued a bond with a negative yield, which means the country is effectively being paid to borrow €4 billion over five years.

–         Be it stocks, bonds, property, or cryptocurrencies, prices continue to rise. Fuelling the boom is ever cheaper debt and a general ability to access money more easily. Elsewhere, data shows that both companies and households are increasing leverage.

–         Benjamin Graham, the father of value investing, said the secret of a sound investment is a “margin of safety”. What he meant by this was the price paid for an asset should allow for a range of unexpected adverse outcomes. Because many things can go wrong at once, it is prudent to be cautious. The actions of many market participants today tell us that many are becoming increasingly incautious.

Focus on the only thing that matters

 –         While it is the nominal index level that makes headlines, it is far less important than valuation. The cyclically adjusted 10-year price-earnings ratio (CAPE) in the US currently stands at 30x. Its long-term average (the data goes back to 1881) is 17x. This indicates that today investors are willing to pay an unusually high price for a stream of profits. For context, the US market CAPE has only reached its current highs twice before; during the dotcom bubble (when it reached an all-time high of 44x) and in the build-up to the Great Crash of 1929 (when it peaked at 32x). 

How do those that ignore the past justify paying high prices today? 

–         “This time it is different”. These are the four most dangerous words in finance, which may be a cliché, but they are used to justify paying up for expensive stocks today.

–         To value the future earnings that you can expect from owning shares in a business, you must discount them using an interest rate. Today, ‘this time is different’ echoes around the belief that real interest rates are expected to be lower for longer. That, as theory suggests, makes a future earnings stream more desirable and justifies higher prices for financial assets. This is how, in a low interest world, higher CAPE numbers are justified. However, paying higher prices causes those buying them to take on increasing risk, whether they recognise it or not.

A high CAPE doesn’t necessarily mean stocks are due a fall

–         CAPE is a mean-reverting phenomenon. From today’s elevated headline figure some infer that mean reversion implies an imminent correction to asset prices. While this is a possibility, historically a significant amount of the CAPE's mean reversion is realised by earnings catching up with stock prices, rather than the other way around. With global profit margins nudging all-time highs, we may question the likelihood of this, but irrespective, we can say with confidence that with valuations higher than average, returns are likely to be lower than the long-term average over meaningful time periods.

Extract the value premium to turbocharge investment returns

–         It is also crucial to point out that the market valuation is a simple average of the individual stocks within it and within those stocks there remain some attractive opportunities. It is these opportunities that give us confidence in our ability to continue to extract the c.2% premium return offered to value investors over and above the market itself, through focusing investment in the cheapest parts of the market.

–         Relative to other funds which are overly-exposed to expensive companies, our portfolio’s outperformance should be significant.

Ensure you have a “margin of safety”

–         Dislocations have become extreme and we believe the market’s eventual snap-back to its typical function as an arbitrator of value will be profound. Moreover, when higher asset prices are fuelled by debt, losses tend to be magnified. History suggests that many investors will come to regret the high price they paid for tech giants or bond proxies (stocks which have the yield characteristics of bonds), where there is no margin of safety to be found.

The value investment team

The value investment team is a team of eight investment professionals who work together on the equities desk at Schroders. Over the past decade we have implemented a value investment strategy, a contrarian and proven approach to investing. The value investment team is responsible for over A$20bn assets (at 31 December 2016), managed in a disciplined value style.  The three lead portfolio managers for the Schroder Global Recovery Fund are:

Nick Kirrage, Fund Manager, Equity Value joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Nick and Kevin Murphy took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, they both also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

Andrew Lyddon, Fund Manager, Equity Value joined Schroders as a graduate in 2005 and has spent most of his time in the business as part of the UK equities team. Between 2006 and 2010 he was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 he joined Nick Kirrage on the UK value team.

Simon Adler, Fund Manager, Equity Value joined Schroders in 2008 and the Global Value Team in July 2016, commencing his career as a UK equity analyst and previously a sector analyst responsible for Chemicals, Media, Transport, Travel & Leisure and Utitlites.